A critical amendment to the Wall Street reform bill being debated in the Senate this week picked up a key Republican backer Tuesday. The amendment, sponsored by Sen. Al Franken (D-Minn.), would end the practice of banks choosing which credit rating agency they hire to rate a particular offering. Often, banks will ask raters for a preliminary review, allowing them to pick the rater most likely to look favorably on whatever bundle of products the bank wants to sell to investors.
Sen. Chuck Grassley (R-Iowa), the highest-ranking Republican on the Finance Committee, said today he'd back Franken's effort. The amendment is also backed by Sen. Roger Wicker (R-Miss.), who overheard a Franken speech on the measure on the Senate floor and was intrigued.
Grassley said that he's looking to end a conflict of interest. "If the credit rating agencies are going to make a contribution to market integrity, then they can't be compromised," said Grassley. "This amendment creates a firewall so that a rating agency can be selected independent of an issuer. It goes after conflicts of interest between rating agencies and issuers, and that's a very important area where due diligence was missing leading up to the financial crisis of 2008."
Franken chalked up the odd coupling to regional values. "Iowa and Minnesota share a certain sensibility -- a commitment to fairness and honesty. Wall Street's current system just isn't honest and it's time we clean it up," said Franken.
Under Franken's amendment, a bank would be randomly assigned a rating agency and companies who consistently delivered inaccurate results would be penalized with less business -- the way the free market would work if there was one. The selection process would also open to gates to smaller rating agencies to compete against the oligopoly of the big three raters -- Moody's, Standard and Poor's and Fitch.
Ed Sweeney, a spokesman for Standard and Poor's, laid out his rating agency objections in an e-mail:
* NRSROs would have little incentive to compete with one another, pursue innovation and improve their models, criteria and methodologies. These reduced incentives would lead to more homogenized rating opinions and, ultimately, deprive investors of valuable, differentiated opinions on credit risk.
* If the U.S. government decides it should determine who it wants assigning ratings, then other governments would follow suit and undermine a major benefit of ratings, which is a globally consistent assessment of credit risk.
* Most importantly, having the government assign a rating agency to rate a security could lead investors to believe the resulting ratings were endorsed by government, thereby encouraging over-reliance on the ratings.